The ESG rating (or sustainability rating) is a synthetic judgement that certifies the soundness of an issuer, a security or a fund from the point of view of environmental, social and governance aspects. ESG ratings do not replace traditional ratings, but are complementary to them, and their purpose is to increase the information available and thus improve the assessments and choices of credit institutions.
ESG ratings are prepared by rating agencies specialised in collecting and analysing data on the sustainability aspects of companies' activities. ESG rating processes are based on the analysis of a variety of information including: company documents, data from external sources such as supervisory authorities, trade associations, trade unions, NGOs, company visits and meetings with management.
What aspects are considered in the ESG rating
A high ESG rating reflects the market's recognition of a company's social responsibility efforts and performance. This is a good business card for all stakeholders of the company, from employees to end customers and investors. A good ESG rating helps to improve the image of the company in many ways. Moreover, more and more financial institutions are starting to take ESG ratings into account in the investment screening process.
The parameters used to develop the ESG rating are varied. On the environmental side, the reduction of CO2 emissions, energy efficiency or efficiency in the use of natural resources are usually considered. Social impact is measured by the quality of the working environment, labour relations, supply chain control and respect for human rights. In the field of governance, the presence of independent directors, diversity policies in the composition of boards of directors or the remuneration of top management linked to sustainability objectives are taken into account.
How ESG rating is measured
There are various ESG rating systems set up by different agencies, some of which are performance-based while some are risk-based. ESG rating agencies assess companies according to their ESG policies, systems and measures and collect information from public sources as well as from internal questionnaires and interviews with top management.
The resulting scores are then adjusted in relation to the industry and the competition. The relative performance of the company within its own reference system is then used as a benchmark to obtain a universally comparable rating across sectors.
Before deciding to obtain an ESG rating, a company should establish a solid framework of sustainable processes to ensure that there are sufficient and effective policies and management systems, internal controls, and implementation measures in place to achieve good ESG performance and form a virtuous cycle of continuous improvement and optimisation of performance.
ESG ratings and access to credit
Increasingly, lenders are combining extra-financial assessments (such as ESG ratings) with more traditional parameters in their investment decisions. A company's sustainability efforts are becoming a key factor in determining its medium- and long-term investment options.
Increasingly complex assessment models are being developed in the financial sector, incorporating specific risk and performance indicators that allow sector-by-sector verification of whether the company or initiative being financed is sound and sustainable. This change is significant because it is leading banks to integrate and use tools (e.g. business plans, covenants, etc.) that until now have only been aimed at large companies.
Banks, investors and credit institutions will provide more funding to sustainable companies that are able to report on ESG impacts: this is set out in the Guidelines on loan monitoring and origination of the European Banking Authority (EBA), which require banks to assess companies with an ESG filter as of 1 July 2021. Access to credit and capital markets will therefore be more convenient for this category of companies.
Why measuring sustainability is important for SMEs and start-ups
Reporting sustainability is a lever of growth for SMEs, not only to access loans and financing more easily, but also to identify and measure those dynamics that allow them to stay on the market, extracting cash flows, and adopting virtuous behaviours that can maximise profits and positive impacts.
Banks and investors can be important facilitators for SMEs. By promoting the adoption of social and environmental reporting tools, they bring these issues to the attention of companies that are often already aligned with sustainability objectives but are not always inclined to make their commitment and performance in this area explicit. By demonstrating the benefits of using these tools, banks are helping innovative small and medium-sized companies prepare for the next transition, which in a few years' time will make the measurement and assessment of ecological, social and governance impacts an essential requirement for all companies.